Saudi Arabia’s Challenge: The Transition from an Extraction Economy to a Value Creation Economy by David Snelbecker

10/11/18

Article Summary: Saudi Arabia's transformation from a Value Extraction Economy to a Value Creation Economy requires four parallel advancements: 1) The business enabling environment needs to facilitate efficient value creation. 2) The domestic economy needs to be linked to and integrated into the global economy at a gradual but steady pace. 3) Public investment in physical infrastructure needs to provide the power, transportation, communication and other physical infrastructure a modern economy needs. 4) Investment in people needs to produce a population that is educated (with skills demanded by the economy), healthy, and with adequate social protections.

 

Dr. David Snelbecker is CEO of International Development Group LLC. Dr. Snelbecker is an expert in economic development and transition, having advised numerous governments in the Middle East, Eastern Europe, Asia, Africa, Latin America, and the Caribbean. He holds a PhD from Harvard University’s Kennedy School of Government, where he focused on public investment and fiscal policy. 

 

During the first half of the 20th Century, Saudi Arabia went through a great transformation, from a land of many rulers, with an economy based on limited agriculture and pilgrimage revenues and with a population that was mostly poor and uneducated, to a unified, modern nation-state, with an educated population attaining middle- and then upper-income living standards. This is a transition that was enabled by the country's great abundance of oil reserves.

 

From a Value Extraction Economy. For the last seventy years, Saudi Arabia’s development required an efficiently functioning Extraction Economy. By this, I mean that, in order to enable development, the economy needed to facilitate: extracting oil from the ground; transporting extracted oil to world markets; and using the revenues from sale of extracted oil for the country’s development. These tasks the economy of Saudi Arabia did quite successfully, for nearly a century. This success was possible due to the effective Extraction Economy, even while non-oil sectors of the economy were not particularly efficient or productive.

 

To a Value Creation Economy. Saudi Arabia’s next historical phase, which the kingdom already has embarked on, requires focus not on extracting value from the ground but on creating value. A Value Creation Economy must enable the people of Saudi Arabia to come together in commercial activities that take inputs and produce outputs—goods and services—that are value-added—that is, through which the labor of the Saudi people creates value of the outputs that is greater than the cost of the inputs. Moreover, the Saudi economy needs to produce goods and services competitively among the world's economies, so that the value that the Saudi people produce will be bought not only by Saudis but by the whole world.  In the past the Saudi economy was able to develop financed by oil revenues, even with an overly bureaucratic regulatory environment for business and with poorly focused public domestic investments. During the next historic phase of Saudi Arabia’s development, a conducive business enabling environment and effective domestic public investments are critical to how successfully Saudi people and Saudi firms will create new value.

 

Lessons from Eastern Europe and the former Soviet Union. Saudi Arabia's challenge is somewhat similar to the great transitions of Eastern Europe and the Soviet Union during the 1990s and early 2000s (transitions in which some of these countries were successful and some were not). (Throughout this period I served as an economic advisor in several of these countries, including Ukraine, Kosovo, and Azerbaijan.) See textbox.

The Soviet and East European Experience - An Epoch of Value Extraction

The Soviet era was defined by two key characteristics, one clearly evident and one not so evident. First, for seventy years during the twentieth century, these countries pursued an experiment to build socialism -- an experiment that ultimately failed. The second characteristic, not as evident as the first, is that the whole epoch was enabled only by extraction -- by oil and gas reserves of Russia and Central Asia. Value was extracted from the ground and sold to world markets, and the revenues from value extraction were used to subsidize failing attempts to build socialism in the other sectors of these economies. The Soviet Union not only used oil and gas revenues to support its own efforts to build socialism but also gave subsidies to East European countries lacking natural resources to engage in their own failed efforts to build socialism. Since the 1990s, these countries have worked to build Value Creation Economies, some successfully and some not. The story of Saudi Arabia is different from that of Eastern Europe, but nevertheless there are some similar lessons. While no one was trying to build socialism in the Saudi economy, it is also true that until recent reform initiatives such as Vision 2030 there has been little pressure to reform the economy into a value creation machine, because the value extraction sectors have compensated for and cross-subsidized inefficiencies in the rest of the economy. As a result, the rest of the Saudi economy has not achieved a high level of economic efficiency or value creation.

 

Four Steps to a Value Creation Economy.  Transformation from a Value Extraction Economy to a Value Creation Economy requires four parallel advancements: 1) The business enabling environment needs to facilitate efficient value creation. 2) The domestic economy needs to be linked to and integrated into the global economy at a gradual but steady pace. 3) Public investment in physical infrastructure needs to provide the power, transportation, communication and other physical infrastructure a modern economy needs. And 4) Investment in people needs to produce a population that is educated, with skills demanded by the economy, healthy, and with adequate social protections.

 

1) A conducive business enabling environment. The business enabling environment (BEE) needs to efficiently facilitate commerce. The legal, regulatory and institutional environment need to make it easy for businesses to register, to get various permits and licenses, to operate their businesses, to hire and fire labor, to pay taxes, to seek adjudication of commercial disputes, and to shut down when no longer viable. The conduciveness of the business enabling environment depends on the laws, regulations, and processes and practices of government regulatory agencies. The World Bank’s Doing Business indicators provide a good initial framework for assessing the BEE. The following table presents Saudi Arabia’s ranking by category compared to a total of 190 economies.

Category Ranking
Starting a business 135
Dealing with construction permits 38
Getting electricity 59
Registering property 24
Getting credit 90
Protecting minority investors 10
Paying taxes 76
Trading across borders 161
Enforcing contracts 83
Resolving insolvency 168
Labor market regulation Analyzed but not ranked

 

In this regard, Saudi Arabia scores well in some areas and not so well in others. Dealing with construction permits, getting electricity, registering property, and protecting minority investors are relatively effective. However, Saudi Arabia scores less well for starting a business, getting credit, paying taxes, trading across borders, enforcing contracts, and resolving insolvency. Saudi Arabia has made good progress in recent years in some categories, particularly in the creation of online systems to facilitate processes. Over the last two years, Saudi Arabia has created a business registration online system that merges together the name reservation and the submission of articles of association steps and that permits payment of fees online; has created another online system to streamline property registration; has improved the land ownership dispute resolution mechanism; has improved an online platform for filing and paying taxes; and has improved contract enforcement by introducing an electronic case management system for judges and lawyers.

 

More significant progress could be made in improving the business enabling environment through a systematic approach to map the costs and time required for each regulatory requirement, and then to consider which requirements could be eliminated and which could be reduced in terms of cost and time through legal or regulatory changes or through streamlining the business processes of the regulatory agencies. Such a systematic reform process is how many countries have achieved significant improvements in their Doing Business rankings.

 

2) Integration into the world economy.  Maximizing the economy’s value creation means efficiently producing and selling not only to domestic customers but also to the whole world. Global demand for Saudi goods and services can be a critical fuel for the value creation of the Saudi economy. For this to happen, the economy needs to be gradually opened to a liberal trade in goods and services. Saudi Arabia joined the World Trade Organization (WTO) in December 2005, and became a signatory to the WTO’s Trade Facilitation Agreement (TFA) in July 2016. Saudi Arabia had agreed to meet almost all the TFA’s requirements about reducing the costs and time required for importing and exporting by February 2017. Despite these commitments, Saudi Arabia still ranks 161 in the Doing Business indicators for trading across borders, although has made some progress in the last year with reducing the number of documents required for customs clearance. Businesses report a considerable number of non-tariff barriers to international trade, including through regulatory and bureaucratic practices, as well as challenges with commercial dispute settlement involving international claimants. Considerable progress still could be made in reforming and streamlining the actual processes in place that govern importing and exporting.

 

3) Investment in physical infrastructure.  Efficient commerce needs to be supported by robust physical infrastructure: transportation (roads, rail, air freight, ports); electricity (generation, transmission, distribution); water and sanitation; telecommunications; a country-wide internet infrastructure; and others. In these areas of physical infrastructure, the Saudi economy generally has been relatively strong. Further improvements are needed particularly in areas most important to business, with a special focus on enabling small and medium enterprises (SMEs). In some instances, this requires extending existing infrastructure the “last mile” to SMEs and households.

 

4) Investment in the people.  Investment in people needs to produce a population that is educated, with skills demanded by the economy, healthy, and with adequate social protections.  This investment in people is required for all people, but a particular focus is needed for investment into Saudi women, who previously have been under-represented in labor force participation and who therefore have particularly great potential for increased labor force participation. Saudi workers need not only general education that makes them literate, numerate and capable of analysis, but they also need training specifically in the skills that will be demanded of workers by the new Saudi economy. This requires workforce development programs based on close collaboration between educational institutions and employers. Investments in health and social protections need to provide a generally able workforce while at the same time supporting the country’s most vulnerable groups. 

 

Conclusion.  My experience and that of my colleagues at International Development Group LLC over the last twenty-five years has shown numerous examples of countries increasing their ability to create value by improving their business enabling environment, by integrating into the world economy, and by investing in physical infrastructure and human capital. Further efforts in Saudi Arabia in these four areas similarly will greatly increase the capacity for value creation in the Saudi economy. Such reforms will carry the country on a great transformation from a Value Extraction Economy to a Value Creation Economy.